I have a SIPP and am currently 65 years old.

If I die before the age of 75, I believe the holdings can be passed on to my wife (without any tax problems). If I die over 75, what happens when I pass holdings to my wife?

Would my wife need a SIPP with the same provider so that the holdings could be placed in her name? Would she be taxed?

Finally, when my wife passes, can the holdings be passed onto our two children? As the holdings are a pension, would that final scenario be exempt from inheritance tax?

Manuel

Rachel Vahey, AJ Bell Head of Public Policy, says:

People’s pension funds can form an important part of their overall wealth when they die, so it’s worth knowing exactly how they will be treated when the member passes.

Pension freedoms allow pension funds to be passed to loved ones when a member dies. The pension member can nominate who they would like to receive the pension pot. Ultimately, though, it’s the scheme administrator’s decision who receives it, and although they will take into account a member’s wishes, they will want to make sure any dependant – such as a spouse or partner – is financially secure.

THE CHOICES OF A BENEFICIARY

The beneficiary then has a choice. They can take the pension money as a lump sum or, if they have been nominated by the member or are a dependant of the member, they can take the pension pot as an income, such as drawdown. Drawdown gives them the benefit of taking the funds gradually to suit their needs or to reduce the amount of income tax they could pay, whilst the remaining money continues to benefit from being in a tax-advantaged environment.

If the member dies before age 75, then the beneficiary who receives the pension pot will not pay income tax on any money they withdraw from it. If they choose to take a lump sum – rather than take the money through drawdown – then there will be a test to see if the lump sums the member took during their life plus the inherited amount is more than their ‘lump sum and death benefit allowance’ (which is usually £1,073,100). Any amount exceeding this allowance will be subject to income tax.

If the member dies after age 75, then the whole pension pot will be subject to income tax when the beneficiary takes it, regardless of whether they take it as a lump sum or through drawdown.

Turning to practicalities. Most SIPP providers will work on the basis that if the beneficiary chooses to take drawdown, then they move the inherited pension pot to their SIPP. This can be done even if it’s not with the same provider. If the beneficiary doesn’t have a SIPP, then they will have to set one up.

When the beneficiary dies, if there is any inherited pension pot left over, then this can be passed onto others. However, it’s up to the beneficiary to choose who to nominate to receive the money, as it’s treated as their own pension money. The original member does not get a say in where the pension pot goes next.

WHEN PROBLEMS MIGHT ARISE

In most cases, this may not be a problem, as money may be passed to other family members. But with blended families some issues may arise. For example, a couple married later in life, when they both had children with previous partners. The husband may pass the pension pot to his wife. But she may choose to leave leftover funds to only her children – his step-children – rather than to his full children.

If the original holder of the pension pot would like more control, then they could consider setting up a ‘bypass trust’ to receive the pension funds. But this comes with its own tax implications and complexity for the chosen trustees.

The tax treatment of the leftover funds will depend upon the age of the beneficiary when they die. For example, if the original member died aged 70, then their spouse could withdraw funds without paying any income tax. (If the children took a lump sum, then there would be a test against the deceased beneficiary’s lump sum and death benefit allowance – not the original member’s.)

However, if the spouse then died aged 80, and chose to pass leftover pension pot to their children, then this pension money would be taxed in the same way as earnings when the children withdraw it.

Finally, pension pots are usually not subject to inheritance tax, regardless of whether they are passed on the death of the original member, or on the death of a beneficiary. 

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